New Trade Alert for (BABA)
ALIBABA – Buy October 72.50 Call @ 10.50 or less
Risk Rating: 3.5 (1 = lowest 5 = highest)
Below Break Even Probability: 46%
Max Loss Probability: 25%
Stop Loss @ 50% of premium paid
Record highs have been achieved in two of the BIG THREE market indexes. The shorts have been stuffed once again with US equities the global choice in the chase for yield.
Tech had been troubled but has bounced back to near unchanged for 2016 on an amazing 10% rally run since the July 27th extreme low. More upside exists just to catch up to the 5% plus performance in the S&P 500 and DOW measures.
A stock that has lost luster is ALIBABA, the AMAZON like giant in China. BABA is negative over the last year compared to the AMZN meteoric rise to new all time highs.
BABA has tracked sideways for four months between $72 and $82 to target $92 on the breakout. $90 is the midpoint of the 2014 IPO peak at $120 to the $60 bottom.
Instead of buying long shares, a stock substitution strategy limits risk to the premium paid with unlimited upside profit potential. Less capital is required and the risk is less in dollar terms than buying shares outright.
The Options Way: Unlimited Upside Potential with Limited Risk.
An ALIBABA long call option can provide the staying power in a potential larger trend extension. More importantly, the maximum risk is the premium paid.
One major advantage of using long options instead of buying or selling shares is putting up much less money to control 100 shares — that’s the power of leverage.
Choosing an option can sometimes be a daunting task with all of the choices and expiration months and strikes. Simply put, traders want to buy a high probability option that has enough time to be right.
The option strike price is the level at which you have the right to buy without any obligation to do so. In reality, you rarely convert the option into shares. Simply sell the option you bought to exit the trade for gain or loss.
There are two rules options traders need to follow to be successful.
Rule One: Choose an option with 70%-plus probability. The Delta is a measurement of how well the option reacts to movement in the underlying security. It is important to buy options that payoff from only a modest price move.
There is no need to ONLY make money on the all but infrequent large price explosion.
Any trade has a fifty/fifty chance of success. Buying options ITM options increase that probability. That Delta also approximates the odds that the option will be In The Money at expiration.
Buying better options is more expensive, but they are worth it — the chances of success are mathematically superior to buying cheap, long shot Out Of The Money lottery tickets that rarely ever pay off.
With BABA trading at $81, an In The Money $72.50 strike option currently has $8.50 in real or intrinsic value. The remainder of any premium is the time premium of the option.
Rule Two: Buy more time until expiration than you may need. Time is an investor’s greatest asset when you have completely limited the exposure risks.
Traders often buy too little time for the trade to develop. Nothing is more frustrating than being right but only after the option has expired premature to the market move.
Trade Setup: I recommend the October BABA $72.50 Call at $10.50 or less. A loss of half of the option premium would trigger an exit.
This option strike gives you the right to buy the shares at $72.50 per share, a price at the bottom of the four month range. The option Delta is 78% so this position will act much like long shares at a sharply investment cost.
This October option has three months for development.
The maximum loss if the option expires worthless is limited to the $1050 or less paid per option contract with a stop loss is placed at half of the option premium paid to lessen dollar exposure.
The upside, on the other hand, is unlimited.
The BABA option trade break-even is $83 at expiration ($72.50 strike plus $10.50 or less option premium) about $1.50 higher.
If shares recover to the $90 midpoint from the $120 all time highs to the $60 lows, the option investment would gain 75%+ to $17.50.